Investing in private startups is a hot trend. But, sorry, you’re not invited.

The company carved out a niche by facilitating trades of private-company stock, particularly pre-IPO shares of LinkedIn LNKD and Facebook FB. But once those companies went public, trading volume in the so-called secondary market stalled, and publications including the New York Times predicted that the sun was setting on SecondMarket and other secondary exchanges like SharesPost. Bloomberg reported in January that both exchanges had “wound down” operations.

But that “couldn’t be further from the truth,” SecondMarket founder and chairman Barry Silbert told Fortune recently.

Indeed, secondary trading volume—both at SecondMarket and more broadly—recently surpassed its pre-Facebook IPO heyday. According to data provided exclusively to Fortune, SecondMarket has already facilitated more than $900 million in secondary stock sales in the first half of 2014 alone—nearly quadruple the $250 million it did all of last year. Overall, secondary transactions will total $17.7 billion this year, estimates private equity research firm NYPPEX. That’s nearly 30 times the secondary volume a decade ago, and almost double the 2011 peak volume before Facebook went public. “Many people thought it would disappear after Facebook, and it didn’t,” says Andy Boyd, head of global equity capital markets for Fidelity, who also oversees the firm’s private investments.

Fueling the increase in secondary trading is the Jumpstart Our Business Startups (JOBS) Act of 2012, which raised the number of shareholders a private company could have from 500 to 2000. (Facebook is believed to have gone public when it did because it was about to cross the 500-shareholder threshold.) The JOBS Act was also designed to expand investors’ ability to buy private company stock—thereby helping startups raise money—though the private market is currently still limited to accredited investors who meet certain SEC standards of wealth. But at the same time, companies also cracked down on secondary trading in their shares by asserting their right to veto trades in their contracts with equity-holding employees and early shareholders.

So today’s secondary market, and SecondMarket itself, are not what they used to be: While the old model allowed shareholders to auction their stakes to any willing buyer, sometimes independent of the company’s approval, SecondMarket today only works with the private companies themselves to host official secondary transactions where the companies set the price of their own shares and choose the buyers.

Not only does this limit startup employees’ ability to cash in their private shares, it also shuts out retail investors. “It’s a big change from the market in the early days, where if you had money, and someone had shares to sell, you might be able to get some Facebook stock,” Silbert says. “Not only do buyers have to be accredited, but they basically have to be an institution.”

Unlike venture fundraising rounds, secondary transactions don’t even raise capital for startups; they’re more similar to public-market transactions where shareholders trade amongst each other. So companies can afford to be extremely picky about the buyers in their secondary transactions, and are more likely to choose a respectable institution whose name will act as a stamp of approval on the startup, or who will contribute valuable advice.

Kevin Landis, founder and chief investment officer of Firsthand Capital Management which oversees $400 million, has been investing in Silicon Valley tech companies since the 1990s dot-com boom, but says Twitter TWTR rejected him the first two times he tried to buy its stock on the secondary market. “Just because you like a company doesn’t mean they want to dance with you,” Landis says.

The hottest tech companies—the ones retail investors most want to invest in—are also the hardest for individuals to access, in secondary transactions as well as in direct primary funding rounds. “These companies have investors tracking them down and pounding their door down,” says Bill Siegel, who recently took over Silbert’s place as SecondMarket CEO. “It’s the bad companies that struggle to raise money.”

Indeed, there are plenty of companies that will gladly take retail investors’ checks—and may not even ask whether they are accredited or not. But those companies are more likely to be young and desperate for money, signaling risk. And they’re also less likely to negotiate with individuals, so the deal terms—even if investors are savvy enough to know what protections to ask for—may be less favorable, perhaps not even granting the investor the right to regular financial disclosures, says Georgetown University law professor Don Langevoort, who specializes in securities regulation.

“What is sold is not Facebook, but it’s a company you’ve never heard of,” says Langevoort, who uses the word “wager” instead of “investment” for those kinds of deals, and compares it to buying a lottery ticket. “If I were an investment adviser I would tell all of my well-off clients, just don’t even listen to those pitches.”

Interestingly, SecondMarket itself says it doesn’t think private-company shares are appropriate for any individual investor—and says it will never get into the trendy equity crowdfunding business, even though forthcoming JOBS Act rules (long awaited, and expected as soon as later this summer) would allow even the average person to invest in startups. After all, SecondMarket has several hundred shareholders of its own (between the company itself and funds it runs), many of whom are angel investors, and yet fields anxious calls regularly.

“It doesn’t take long for an individual investor to start asking questions about when they can get out,” Siegel says. “Imagine that if you were to put these investments in the hands of people who are just used to holding stocks and cash? I don’t see how that could ever be tolerable. I see a real recipe for a lot of disappointment; it’s a recipe for trouble, quite frankly.”

Should you buy stock in private companies?

Nelson Griggs used to have a relatively straightforward job. As a senior executive for Nasdaq OMX, Griggs’s primary task was to persuade companies that were planning to go public to choose his company over its archrival, the New York Stock Exchange. But regulatory changes in recent years have added to the aggravation of being public while making it easier for businesses to stay private and still raise capital. As a result, companies have been waiting longer and longer to have an IPO. So Nasdaq met them in the middle: In March it launched Nasdaq Private Market, a new exchange for companies not traded publicly to offer their stock to investors. Suddenly Nasdaq isn’t courting just firms on IPO road shows, but also Silicon Valley startups and even the most closely held, mature private businesses across the country. “Are the lines blurred between public and private? Yeah, they are,” says Griggs. “Our view is that this is the future.”

“We’re seeing more and more opportunities in private companies than we ever have.”—Andy Boyd, head of global equity capital markets for Fidelity.

In fact, trading in private shares is already one of the hottest trends in investing. NYPPEX, a private equity adviser and research firm, estimates that there will be $17.7 billion in secondary sales of private-company securities this year, up 43% from the $12.4 billion in sales last year and 5,800% from the $300 million in 2002. Where private, unregistered shares were once largely the domain of venture capitalists and private equity firms, they are increasingly attracting traditional money managers—and even individuals. The five mutual fund companies most active in the private market—Fidelity, T. Rowe Price, BlackRock, Janus, and Wellington Management—have in the first half of this year already participated in 24 private-company deals (including Uber, Airbnb, and Dropbox), more than the 18 they did in all of 2013, according to CB Insights. Mutual funds are even getting into primary funding rounds to capture more of companies’ early growth. “We’re seeing more and more opportunities in private companies than we ever have,” says Andy Boyd, head of global equity capital markets for Fidelity.

The vogue for owning shares of private companies can be traced to the mania around Facebook. Demand for its shares in the run-up to its 2012 IPO gave rise to frenetic trading on the secondary market—on online exchanges such as SecondMarket and SharesPost, where vested employees and original shareholders sold stock in order to cash in a portion of their stakes. Many had assumed that such trading would wane after Facebook went public, but the opposite has proved true. The practice got another boost from the Jumpstart Our Business Startups (or JOBS) Act of 2012, which allowed companies to take on as many as 2,000 shareholders before registering, up from 500. As the business has grown, the transactions have become more formal, resembling mini-IPOs: SecondMarket as well as Nasdaq Private Market, a joint venture with SharesPost, now specialize in secondary transactions in which the private companies themselves organize sales, or “liquidity programs,” between existing shareholders and select investors.

PARTIAL TO PRIVATES
The market for nonpublic shares is growing as companies wait longer to have IPOs.Graphic Source: NYPPEX

One mutual fund manager who has embraced private shares is Henry Ellenbogen of the $16 billion T. Rowe Price New Horizons Fund, which has long specialized in early-stage growth companies. “It really doesn’t matter if our investments in those companies happen to be public or private,” he says. Since joining the fund in 2009, Ellenbogen has invested in about five to seven private companies each year. Those investments, which currently make up 3.6% of his portfolio—plus some, like Zulily, that are top holdings since going public—have helped the fund post the best five-year performance among small-cap growth funds, returning nearly 23% a year on average. Although securities law and the fund’s charter permit Ellenbogen to invest as much as 15% of assets in illiquid stock, “we don’t want to get anywhere near that,” he says. If a market correction came around and wiped out his public holdings, the private investments would suddenly account for a much larger chunk of the fund. And his ability to sell private shares to raise cash would be constrained. “When private markets are hot, like they are now, there is an illusion of liquidity in the private market, but it’s something we would say is a limited phenomenon,” says Ellenbogen.

Indeed, private shares come with some giant asterisks: They are restricted securities by definition, meaning they are bound by all sorts of limits governing when they can be sold and to whom, and they’re considered completely illiquid. Then there’s the inherent risk of fledgling companies. Like baby sea turtles to the ocean, many venture-backed tech startups will never make it to the public markets or reward their investors at all.

Kevin Landis has learned that lesson the hard way. The manager of the Firsthand Technology Value Fund was a star of the late-’90s tech boom. In 1999 he had the best five-year record among all mutual funds. But when the bubble burst, his returns tanked. Landis soured on publicly traded stocks. (“Probably the last great one for us was Netflix,” he says.) He saw much more growth potential in private shares. In 2011 he converted his portfolio to a closed-end fund so he could invest more in private companies without compromising his shareholders’ liquidity, and he managed to scoop up 600,000 Facebook shares on SecondMarket for an average cost of $31.50 apiece. He expected the company’s record IPO in 2012 to be a major win for his fund. But because of lockup restrictions, Landis couldn’t sell any Facebook shares for six months, during which time the stock slid from its opening price of $42 down to $19. It was trading in the low 20s when the lockup finally lifted. “Imagine the emotional roller coaster of that,” says Landis. He has held on to the Facebook shares, which recently traded at $73. But that’s “not a put-me-in-the-hall-of-fame type of thing,” he grouses.

In the three years through July, Landis’s fund has returned about 11% annualized, compared with 17% for the S&P 500; since Facebook’s IPO, it has dropped more than 20%. It hasn’t helped that portions of the fund have been frozen in illiquidity longer than Landis expected: He owns Gilt Groupe, which has been rumored to be going public for several years yet remains private. Now Landis has once again come to appreciate the “beauty” of public companies. “You can change your mind!” he says. “Private investments—that’s a roach motel. Dollars go in, and they never come out.”

For stock pickers, private companies take a great deal more work to research—and, often, to woo. Hot tech companies like Uber and Dropbox generally won’t accept individual investors after early funding rounds, no matter how wealthy they are. (Under current law, investors can buy private securities as long as they are accredited—meaning they have a net worth of at least $1 million or have had an annual income of $200,000 for the past two years. An expected second round of JOBS Act regulations would extend the right to invest in private companies to the average person.) Even Fidelity and T. Rowe Price report that startups have occasionally declined their offers to invest.

Once you’re in, the investment process is surprisingly low-tech and old-fashioned. There are nondisclosure agreements to sign. The company’s financial documents often can’t be downloaded or even printed; sometimes they may be viewed only in paper form, at the company’s office. And prices aren’t driven by markets: Companies set the price of the shares they sell on NPM and SecondMarket and select the buyers, so there are no bidding wars. “It’s a lot more like a real estate transaction than a stock trade,” says Griggs. Plus, unlike public companies, private companies don’t owe their shareholders regular financial updates and disclosures. So savvy investors take pains to secure additional contractual rights. Even with Fidelity’s 300-plus equity analysts and investors at his back, Boyd says he negotiates for all sorts of protections in Fidelity’s contracts with private companies—including preferred stock and frequent audited financial disclosure. “Remember, these are private companies that are keeping information private, and we don’t want to be surprised and find out that, oh, something blew up a month ago,” he says. Add it all up, and experts advise against individuals buying into private shares. Even SecondMarket, one of the biggest proponents of liquidity in private securities, doesn’t think the average non-accredited investor belongs in that market.

The safest way for retail investors to participate is through mutual funds that allocate a small portion of their assets to private companies. Ellenbogen closed his T. Rowe New Horizons Fund to new investors in December in part because he was concerned about high valuations in both public and private stocks. But there are other top-performing funds that offer exposure to private shares. The Fidelity New Millennium Fund, for example, has invested about 1% of its assets in a handful of private companies. And the USAA Science and Technology Fund owns pre-IPO names such as Pure Storage and Cloudera.

When might we expect a more open market in private securities? Nasdaq’s Griggs says that day is still “way, way far away.” Until then, the simplicity of public markets is hard to beat.

Last night SecondMarket, the company behind the marketplace for trading shares of private companies, announced that its chief executive and founder, Barry Silbert, would step down to focus on all things bitcoin. If you’ve been following Silbert, that should be no surprise—the man has been a major Bitcoin enthusiast and investor in the sector, backing at least 30 companies in recent years. He’ll now head up SecondMarket’s bitcoin business full-time and serve as chairman of SecondMarket Holdings, the parent company to both businesses.

But where does that leave the company? In 2011, SecondMarket was heralded as the latest innovation in employee retention and investment democracy. (Now, anyone can buy pre-IPO Facebook!) SecondMarket even raised $34.2 million in venture funding itself from Social+Capital Partnership, FirstMark Capital and Temasek Holdings.

But then pre-IPO Facebook FB share sales descended into utter chaos. As I wrote in Monday’s column, startup CEOs and investors are increasingly saying “no thank you” to secondaries. I spoke with SecondMarket’s interim CEO, Bill Siegel, about that last night. He’s been running operations for SecondMarket since 2011. (The interview has been condensed and lightly edited for clarity.)

How have SecondMarket’s products changed since the Facebook era?

Late 2011 was the fever pitch of pure, over-the-counter, pre-IPO private company stock trading mania, centered mostly around Facebook. We knew Facebook was going public, and that was obviously a large source of revenue. But the market was shifting, starting a year prior to that. A lot of the other private companies didn’t like the way the pre-IPO market was shaping up.

We began to formulate a product around what private companies wanted and desired. The first was a legal solution. You could structure these things as tenders keep them private. The company controls the rules, the price, who can sell and how much, not the external broker or some buyer that is scalping around for shares. Then we productized the user experience.

How has that worked for you?

We have been developing this since the private market wound down [in early 2012]. These are very private transactions. We are having, in 2014, a record year. We’ve done almost $1 billion in private company secondaries in first half of this year.

Do you agree with what we wrote on Monday, that startups are increasingly wary about letting shareholders cash out early?

I can understand why companies are really reticent, and its why we changed our model back in 2011. The companies were being really proactive. We heard from the companies saying, “Quite frankly, [selling shares] should be outlawed because its so distracting. We don’t want anything like [what happened at Facebook] to develop and we’re looking at ways to change the bylaws in our businesses so it can be explicitly outlawed.” Venture firms have said when founders are forming their companies, they’re [outlawing share sales] at that stage. That was when we realized a different solution was going to be required.

The pressure to give employees a little bit of liquidity will not go away. Fast-growing businesses are going to see the pressure increase and its a question of resources. The last thing you want to do when you’re the CFO is to hire three people to do stock plan administration because of all of the employees screaming for liquid equity.

The right-of-first-refusal (ROFR) requests are not going to stop as you grow and get more mature and build up a large ex-employee stockholder base. There are always going to be people looking to buy that stock and looking at those ex-employees. The easiest way is to do a broad-based tender and clean up the cap table. A lot of the tenders are set up to align incentives. For example, a current employee can only sell 10%, but ex-employees have to sell 100% or nothing.

Who are the most common buyers on SecondMarket today?

One third is just the company tendering and using their own cash to buy back shares. Two thirds are third parties. Out of those, the most common are mutual funds—75% are mutual funds, the other 25% are hybrid growth hedge funds. The mutual fund involvement is certainly notable. The sheer fact that these companies are waiting so much longer to go public and that value creation is accruing to venture investors is the main impetus for a lot of these mutual funds.

Are you doing more volume now than you were before Facebook?

This year we’ll do the same amount of private company secondary transactions that we did in the years where Facebook was at its largest. That’s notable because the size and velocity with which Facebook was trading during those years was gargantuan. We’ll do on the order of 50 to 60 transactions this year.

After Facebook, SecondMarket had layoffs and scaled back. Have you expanded back to the same size you were in those days, too?

No, we had a significant team. We’ve refined our sales and marketing model so its not as intensive as it was back them. That was over-the-counter, all phone-brokered at the time. We are not a phone broker anymore, we’re a product and technology company. No longer is the focus on trading, so it’s taking as little labor as possible to transact these secondaries.

You’re VC-backed as well. What’s ultimate outcome for SecondMarket?

We have a big market to get into and a few more products on the slate. It’ll be heads down for at least a couple of years.

What’s the future of secondaries?

The trend is towards repeat and recurring [tender offerings], and that is being messaged to employees at the company. People look at [equity] as a lottery ticker kind of. When you run [a tender offer] every year or twice a year, that shifts the way the employees view that stock. This is actually now compensation. It’s not just a lottery ticket. That’s really meaningful, especially for growth companies. Companies can use that as a retention tool, and it can be a meaningful part of compensation.

Illiquid Till Exit: Is the golden era of secondary share sales over for startups?

Any startup that’s raised capital with a valuation in the hundreds of millions is on the radar of hedge funds, secondary market players and various other boiler rooms for private company stocks. (Call them “spawn of Advanced Equities.”) And it’s creating a thorny issue for startup CEOs.

With startups waiting longer than ever to go public (and thus, leaving less hyper-growth on the table for public market investors), public market investors are under pressure to find high-growth opportunities in the private markets. When Dropbox raises $350 million, or Uber raises $1.2 billion, it’s basically like an IPO, except it’s not open to all retail investors.

So these funds are getting aggressive in their quest for private company shares. One way they’re doing that is by blasting out solicitation emails to startup employees, offering to buy their shares at astronomical valuations. The offers might not be serious — it’s hard to know — but its enough for employees to get dollar signs in their eyes. It’s enough to prompt them to ask management about cashing out.

This poses a problem: The company ’s board has a fiduciary duty to take any offers seriously, but at a ridiculous valuation, how can it? Further, if the company does say yes, it now has a random fund in its cap table, at a valuation much higher than the rest of the shares. There’s little precedent for deciding what class of shares the new buyer gets, and at a higher valuation, how many they get. “It’s a CFO’s nightmare,” one VC said. Not to mention, the insider trading laws for public companies apply to private companies as well, making compliance expensive and cumbersome as the shareholder base expands.

Those issues are why, increasingly, companies are following the lead of startups like Dropbox and Uber and saying no to employee share sales. Based on an informal survey of investors, that’s been the trend since Facebook, which turned into the Wild Wild West of secondary shares before its IPO. At the time, SecondMarket and its peers were hailed as an innovative, entrepreneur and employee-friendly way to do business. It creates a real market with real values for private company stock, with less volatility, declared the New York Times. Secondary markets “act as a stent, relieving the congestion in the arteries of capital formation,” proponents told Businessweek in 2011. But the accounting nightmares it created left investors and CEOs who witnessed it turned off by the idea.

The pendulum has since swung in the other direction, the investors Fortune surveyed said. (They requested anonymity to avoid the appearing unfriendly to entrepreneurs.) Venture firms now make strong recommendations to their portfolio company CEOs as early as a Series A fundraising that employee stock sales remain forbidden until a liquidation event. Companies have always had the right to refuse a potential share sale — they’re simply refusing a lot more now. If employees want to cash out, they have to wait for an honest-to-goodness exit.

There’s one little issue with this shift: Saying no to employee requests for share sales becomes a poaching issue. Top executives at companies like Uber and Dropbox are among the most in-demand talent in Silicon Valley, and that’s not lost on Google, Facebook and Apple. The big public companies can offer an executive, say, a $5 million stock package with full liquidity. Uber can offer the promise of an IPO… someday.

The move to more conservative secondary sale policies hasn’t stopped funds and advisory firms focused on buying shares from startup employees. (Take Battery East Group, a firm founded by former BlackRock exec Michael Sobel, and former Maveron advisor Barrett Cohn, for example.) But the new twist on secondaries seems to be loans over share sales. Earlier this month, 137 Ventures raised $137 million to lend money to private company shareholders and employees who are rich on paper with illiquid shares. Another firm called VSL Partners, founded by GSV Capital partner Dave Crowder will offer the same thing.)

So, if startups are becoming stricter about employee share sales, where will the funds hungry for private company shares invest their capital? Turns out, it’s all about who you know. CEOs are much more likely to approve a secondary sale if it’s to a firm they know and trust, and many of the firms springing up to facilitate sales start out with a relationship. Growth-hungry hedge funds and boiler rooms take note — befriend the next Drew Houston or Travis Kalanick, and you might have yourself a deal.